Tuesday, 15 July 2014

Banco Espirito Santo - risk, reward, circle of competence and coattailing

For a day last week the international markets went crazy on the reported falling of the a main portuguese bank. The problem was that some people didn't understand the difference between Banco (bank) Espirito Santo -BES- and Grupo (group) Espirito Santo - GES.

Today that has already become reasonably clear to everybody: GES belongs (partially) to the Espirito Santo family and GES owned 25% of BES (through Espirito Santo financial group, ESFG, this is quite an holding cascade). However, if look deeper we might notice that today GES owns (most likely) only 0,1% of BES. In fact Nomura  margin called them and aquired 4.9% (or 5%, I'm not exactly sure) of BES. Additionally, ESFG sold some debt which it can elect to pay with shares equivalent to 20% of BES valued at a price of €1.3129 (it currently trades at 0.38€). If ESFG bankrupts it is likely that those 20% will automatically settle the loan. So they actually own 20.1% of BES but are highly likely to soon own only 0.1%.

So we have the difference reasonably settled: the espirito santo family owns a holding that holds a holding that holds a holding (...) that holds 40 something% of a holding that owns 20.1% of BES, that actually are likely to be 0.1% in the future (maybe a not so distant one). In addition the management of BES change yesterday and the new managers not only aren't related to the Espirito Santo family, but actually are unlikely to be very sympathetic to them (they have a good reputation and most likely want to keep it clean, in fact they wanted to wait until the results are out to enter the group so that they wouldn't launch results they didn't have the opportunity to check). So basically GES and BES are almost totally independent right? Not so fast.

The problem is that only some months ago they were in charge of the bank:
- it has already been disclosed a significant direct exposition of BES to GES: since it is quite complicated I leave the link http://web3.cmvm.pt/sdi2004/emitentes/docs/FR51236.pdf
- there are fears that there might be further exposition either direct or indirect
- there are fears that the quality of management that led to the current GES situation might show up also in BES
- in a related note it seems that BES Angola (which belongs to BES) is in a distressed position. That would imply no further problem if BES couldn't be called to cover a part of the hole there (it is said that BES might have to put up to 2000-3000 million there). This is one of the big question marks. Actual exposition doesn't seem clear, but it is worth noting that the Angola government warrants about 4000 million of the about 6000 million credits there and it is said that BES Angola might be nationalized there. Here I can had no insight, I haven't studied this situation.

However, it is not all bad news:
Banco de Portugal (the regulator) has been all over this situation for months. They have been trying to insulate BES from the group:
- As you can read on the link, ESFG has had to establish an"unconditional and irrevocable guarantee of EUR 700 million". Whatever that is it might mean that part of the problem might be covered (as long as ESFG can cover it, they say they can)
- BES exposition to GES was already known by BP and as such BES had to make a capital increase of over 1000M€ last month at 0.65€, after which the bank traded around 1€
- the new independent management most likely was chosen under pressure from Banco de Portugal and they had to start their work there before their chosen date
-the new management is said to have asked today an audit to the company numbers
-today the previous CFO (if I'm not mistaken), who the family had initially proposed to CEO instead of the current management seems to have left the BES management.
- Seth Klarman, through Baupost, disclosed a position in BES last week, when the bank was trading around 0.5-0.6€ (today closed at 0.38€).

So what should I do?
1- Banking is out of my circle of competence. I could try to learn it but I doubt it would be useful in this particular case.
2- Distressed investing is out of my circle of competence. It isn't however outside Seth Klarman's circle and I believe I read/heard some years ago that Klarman was at the time the only fund manager he recomended (from those he could promptly remember).
3- I like coattailing but only to get ideas, I don't coattail blindly
4- I am not an high risk/high reward type of investor. Taking my circle of competence into account this is a very high risk situation for me

As such, I'm out and I won't regret not getting rich with this one. But if Klarman paid much more than you could pay today it might be worth your attention

disclosure: no position. I might have got something wrong on the info above. I believe it to be reasonably accurate but ALWAYS do your own due diligence.

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